Target benefit plans (TBPs)—pension arrangements where the risk is shared between the employer and employees—are attracting more and more attention. But despite this model’s appeal, a number of pension plan sponsors have concerns about the technical details associated with moving to a TBP structure.
TBPs are seen as a middle-ground solution that can mitigate the risks associated with both DB and DC structures.
“On the DB side, what we’re talking about is the employer volatility to fund deficits when they arise,” said Kevin Sorhaitz, partner with Morneau Shepell’s retirement solutions practice, speaking at Benefits Canada’s recent Benefits & Pension Summit in Toronto.
The TBP model also addresses some of the surplus issues, according to Sohraitz. “You build up reserves and you don’t take contribution holidays” because you will need them for a rainy day, he explained.
On the DC side, the risks can stem from market volatility as well as plan members not saving enough money and lacking the financial sophistication to make investment decisions, all of which can result in insufficient retirement income.
TBPs, which originated in New Brunswick, are essentially a hybrid between DB and DC plans where the goal is to collect defined pension contributions in order to secure a targeted benefit in retirement. Benefits and contributions adjust over time based on the performance of the plan. If the returns are lower than expected, the plan raises the contributions and/or reduces the size of the benefits, without putting plan sponsors on the hook. If the returns are higher than expected, benefits could be increased or contributions could be reduced.
“If you see there’s not enough money coming in, you know ahead of time what the adjustments will be,” Sohraitz said. “This all gets negotiated upfront. If we need to adjust contributions a little bit, we do it. It’s already been agreed.” Under this model, sponsors and members avoid the difficult negotiations that take place every time the plan has to make a change, Sohraitz added.
He said another good feature of TBPs is that they force plan sponsors to evaluate their plan’s health more regularly than they would under a DB framework. “I’m always surprised when I hear plan sponsors say, ‘We measure our plans every three years because that’s what Ontario requires.’”
New idea?
The idea of a risk shared pension model is hardly new. “The original TBPs would be your multi-employer plans and your jointly sponsored plans, which are unique to Ontario. It’s not a new model, but it hasn’t been available to everybody.”
However, that could change—last month the federal government proposed legislation for TBPs. The voluntary framework would be available to federally regulated private sector or Crown corporations; it would not affect the core public sector pension plans, which are subject to a different type of legislation. Federally regulated industries include banking, transportation, telecommunications, and radio and TV broadcasting. Canada has 1,234 federally regulated pension plans.
Accrued benefits
While the TBP model may look attractive, many sponsors on the DB side have concerns about the technical details involved in transitioning to that structure, such as the fate of accrued benefits.
Jana Steele, partner, pensions and benefits group, with Osler, Hoskins & Harcourt LLP, recommends looking to New Brunswick for direction. “New Brunswick is a good example of a jurisdiction to look at. They brought it in two years ago, and they’ve been living with the plans and dealing with the bumps in the road.”
New Brunswick has permitted conversion of accrued benefits, Steele explained. “If you’re a DB plan and you want to convert to shared risk, you can convert all accrued benefits to shared risk.”
Base benefit reductions
Another concern DB sponsors have is the possibility of reducing base benefits that is embedded in the TBP framework. But Sohraitz said this reduction is usually a measure of last resort.
“To get to a reduction in base benefits, you are in a really bad scenario,” he said, explaining that this kind of scenario can be averted given that the plan looks at its funding position more often.
Base benefits are usually not subject to reduction, so before cutting benefits across the board, the plan should take other steps, such as raising contributions.
While there is no decision yet on the federal TBP legislation and some details remain unclear, the pension industry can still go ahead in that direction, according to Sohraitz. “We have these best practices out there. We see what New Brunswick is doing. Those concepts are not unique. We need to be applying them today to our plans.”
All the articles from the event can be found on our special section: 2014 Benefits & Pension Summit Coverage.
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